Reflections on Today’s Netflix Earnings Call

by Davis Freeberg, Staff Writer

Editor’s note: Davis Freeberg is currently a Netflix shareholder and customer.

Netflix reported third quarter earnings this afternoon and announced that they now have 3.59 million subscribers. This was up about 61% over a year ago and represents an increase of 12% over the last three months. They recognized revenue of almost $175 million for the quarter and GAAP net income of $6.9 million. While they did beat earnings estimates by .01, their numbers were very much in line with the guidance that they gave at their analyst day last September.

As is typically the case, however, the more interesting points had little to do with Netflix’s earnings and more to do with the future development of their technology. Unfortunately what came as a bit of a surprise today was that their previously announced joint effort with TiVo, frequently dubbed TiVoFlix, will not only not be available by the end of the year but it is essentially dead in the water until “the content climate begins to thaw and it becomes possible to develop a compelling consumer experience.” Netflix CEO Reed Hastings was quick to emphasize that the difficulty in getting content wasn’t just isolated to Netflix – Apple, Comcast & Movielink all face similar challenges in securing digital licenses for films on demand. Hastings went as far as to say that he saw Comcast, Movielink and Apple as their allies and that their shared opponents were the “TV channels who pay large sums to get multi-year exclusive access to films.”

For all of the attention that Netflix has received as a first mover in the DVD rental space, it is unfortunate that they are not willing to push the envelope and pioneer a download product as well. While I can understand not wanting to release an inferior product to the public, I think that they are giving up momentum to Apple by delaying the launch of their VOD product. The VOD marketplace is very young and while not everyone wants to watch TV on a portable device, long term brand decisions are still being made today. As Eric Rice, the co-founder of audioblog.com, so aptly puts it, “We subscribe to brands.”

By abandoning even small efforts for an even inferior VOD product, Netflix risks giving up a potential leadership position in VOD. While VOD was never initially expected to create significant revenue for Netflix, their plans to put the service on pause shows that the market for VOD will be a much tougher fight than their battle for DVD dominance.

Some of the other interesting points brought up in today’s analyst call include the note that Netflix is seeing their demographics begin to shift older. I suspect that this has more to do with their most recent ad campaign that seems to target busy soccer mom’s over past initiives targeting younger users. They also reluctantly disclosed to investors that disc usuage was down, but refused to provide a percentage of how much this has fallen. This may have been one of the reason for their historically low churn rate of only 4.3%, but analysts could not get the company to comment on whether this is a long term trend or whether this was a seasonal event – only that it fell almost exactly with what their expectations were.

Personally, I know that I do not watch my Netflix movies as often as when I first had the service. I’m not sure whether this has more to do with the throtling of my account or whether the novelty of renting DVDs by mail has begun to fade for me. If this does turn out to be a longer term trend then it should help increase Netflix’s profits as their business matures.

Hastings also told investors that over the next six months, Netflix plans on testing new pricing plans “to determine if at lower prices we can deliver faster sub growth lower sac [subscriber acquisition costs], lower churn, higher competitive barriers and still deliver on our earnings committment.” Hasting believes that if these lower price points work it would “increase the economic pressures on video stores,” and would create a “tipping point” for online rentals.

Hastings was quick to point out they are starting to see video stores closing in the bay area, where Netflix has their highest penetration (aproximately 11% of the population uses Netflix). They are also finding that growth has continued to accelerate in their heavy penetration areas and that SAC expenses were significantly lower then in other areas of the country.

One thing that was never brought up during the call was any news on Netflix’s previously announced plans on automating their fulfillment centers and any cost benefits or expenditures that would result from this automation. After hearing last quarter, that they planned to spend $8 million on upgrading their fulfillment centers, I was disappointed to hear no mention of it today. While they were quick to discuss their capital expenditures during last quater’s call, they seemed less willing to this quarter. At one point during the Q&A; they refused to provide Capital Expenditure guidance going forward. While normally, I’m content to let companies keep their secrets, I do think that Hastings crossed the line because he had discussed the expenses in last quarter’s call and promised to provide more details about the benefits on this quarter’s call. While he was never asked specifically about their upgrade plans, it does make me concerned that they felt it was important enough to discuss a .02 cent postal increase, but did not feel that it was important to point out how much of this increase would be offset by the automation. Perhaps they choose not to disclose this information because of Blockbuster’s adoption of their own inventory management system or it could be that they simply didn’t feel that it would impact shareholders, but they should have at least addressed how much of their variable costs will be offset by this implementation.

Overall, it was another strong growth quarter for Netflix and while the core business continues to grow at a strong pace, I’m left feeling empty inside from the call. Whether it’s the abandonment of their TiVoFlix plans or Barry McCarthy’s statement that “we don’t feel like we are missing any opportunities internationally,” it was clear that Netflix failed to innovate this quarter. While this could be a temporary setback for the company, it is frustrating to see Hollywood still remains in the denial phase when it comes to accepting technology.

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One Comment

  1. Aron says:

    Do you buy the line about Apple, Comcast, et al being allies?

    IMO, A rapid transition to VOD would be disastrous to Netflix who does not stand to benefit as materially as they can from their existing model. If I expected VOD to be “right around the corner” I would exit my position.